4. Risk in interest rate swaps Use the following table to determine which type of swap market risk each example best represents. Example Risk Type The Russell 2000 index is used on a swap and decreases by 0.6 percent over a four-month timeframe, while the interest rates a U.S. bank pays its depositors for funds decrease by 0.2 percent. As a result, the interest rate payments tied to the Russell 2000 do not offset the bank's cost of funds. Community Bank takes dozens of swap positions and guarantees dozens of swaps as an intermediary for parties engaging in swaps. If participants in the swaps that the bank guarantees begin to default and the bank starts having cash flow issues, then it might start defaulting on some of its swap positions. A U.S.-based investor engages in swaps with a French-based company; however, the French government nationalizes the company and decides not to honor the swaps. Grade It Now Save & Continue Continue without saving 5. Factors affecting interest rate swap pricing Suppose Ledger Company engages in a plain vanilla interest rate swap with Ziegler Company, where Ledger Company is the party making fixed interest rate payments. Suppose there are two scenarios: (1) prevailing market interest rates are 7% when the swap is created, and (2) prevailing market interest rates are 3% when the swaps are created. Under which scenario would you expect the fixed interest rate on the swap to be lower? O Scenario 1 O Scenario 2 Suppose Blackwell Bank engages in a plain vanilla interest rate swap with Hedgington Bank, where Blackwell Bank is the party making fixed interest rate payments. Suppose there are two scenarios: (1) 12 investors are willing to serve as the counterparty on the swap, and (2) 4 investors are willing to serve as the counterparty on the swap. Under which scenario would you expect the fixed interest rate on the swap to be higher? O Scenario 1 O Scenario 2 Suppose Maplewood Company engages in a plain vanilla interest rate swap with Hawkeye Bank, where Maplewood Company is the party making fixed interest rate payments. Suppose there are two scenarios: (1) Hawkeye Bank is based in a country that is known to be politically stable, and they have not missed a payment on debt obligations in over 30 years, and (2) Hawkeye Bank is based in a country known for political instability and constantly makes late payments on debt obligations. Under which scenario would you expect the fixed interest rate on the swap to be lower? O Scenario 1 O Scenario 2 4. Risk in interest rate swaps Use the following table to determine which type of swap market risk each example best represents. Example Risk Type The Russell 2000 index is used on a swap and decreases by 0.6 percent over a four-month timeframe, while the interest rates a U.S. bank pays its depositors for funds decrease by 0.2 percent. As a result, the interest rate payments tied to the Russell 2000 do not offset the bank's cost of funds. Community Bank takes dozens of swap positions and guarantees dozens of swaps as an intermediary for parties engaging in swaps. If participants in the swaps that the bank guarantees begin to default and the bank starts having cash flow issues, then it might start defaulting on some of its swap positions. A U.S.-based investor engages in swaps with a French-based company; however, the French government nationalizes the company and decides not to honor the swaps. Grade It Now Save & Continue Continue without saving 5. Factors affecting interest rate swap pricing Suppose Ledger Company engages in a plain vanilla interest rate swap with Ziegler Company, where Ledger Company is the party making fixed interest rate payments. Suppose there are two scenarios: (1) prevailing market interest rates are 7% when the swap is created, and (2) prevailing market interest rates are 3% when the swaps are created. Under which scenario would you expect the fixed interest rate on the swap to be lower? O Scenario 1 O Scenario 2 Suppose Blackwell Bank engages in a plain vanilla interest rate swap with Hedgington Bank, where Blackwell Bank is the party making fixed interest rate payments. Suppose there are two scenarios: (1) 12 investors are willing to serve as the counterparty on the swap, and (2) 4 investors are willing to serve as the counterparty on the swap. Under which scenario would you expect the fixed interest rate on the swap to be higher? O Scenario 1 O Scenario 2 Suppose Maplewood Company engages in a plain vanilla interest rate swap with Hawkeye Bank, where Maplewood Company is the party making fixed interest rate payments. Suppose there are two scenarios: (1) Hawkeye Bank is based in a country that is known to be politically stable, and they have not missed a payment on debt obligations in over 30 years, and (2) Hawkeye Bank is based in a country known for political instability and constantly makes late payments on debt obligations. Under which scenario would you expect the fixed interest rate on the swap to be lower? O Scenario 1 O Scenario 2